2. The balance of international indebtedness is a record of a country’s international:
a. Investment position over a period of time
b. Investment position at a fixed point in time
c. Trade position over a period of time
d. Trade position at a fixed point in time

3. Which balance-of-payments item does not directly enter into the calculation of the U.S. gross domestic product?
a. Merchandise imports
b. Shipping and transportation receipts
c. Direct foreign investment
d. Service exports

4. Which of the following is considered a capital inflow?
a. A sale of U.S. financial assets to a foreign buyer
b. A loan from a U.S. bank to a foreign borrower
c. A purchase of foreign financial assets by a U.S. buyer
d. A U.S. citizen’s repayment of a loan from a foreign bank

5. Which of the following would call for inpayments to the United States?
a. American imports of German steel
b. Gold flowing out of the United States
c. American unilateral transfers to less-developed countries
d. American firms selling insurance to British shipping companies

6. In a country’s balance of payments, which of the following transactions are debits?
a. Domestic bank balances owned by foreigners are decreased
b. Foreign bank balances owned by domestic residents are decreased
c. Assets owned by domestic residents are sold to nonresidents
d. Securities are sold by domestic residents to nonresidents

7. Which of the following is classified as a credit in the U.S. balance of payments?
a. U.S. exports
b. U.S. gifts to other countries
c. A flow of gold out of the U.S.
d. Foreign loans made by U.S. companies

Table 10.1 gives hypothetical figures for U.S. International Transactions.

10. Unlike the balance of payments, the balance of international indebtedness indicates the international:
a. Investment position of a country at a given moment in time
b. Investment position of a country over a one-year period
c. Trade position of a country at a given moment in time
d. Trade position of a country over a one-year period

11. Which of the following indicates the international investment position of a country at a given moment in time?
a. The balance of payments
b. The capital account of the balance of payments
c. The current account of the balance of payments
d. The balance of international indebtedness

12. Concerning the U.S. balance of payments, which account is defined in essentially the same way as the net export of goods and services, which comprises part of the country’s gross domestic product?
a. Merchandise trade account
b. Goods and services account
c. Current account
d. Capital account

13. If an American receives dividends from the shares of stock she or he owns in Toyota, Inc., a Japanese firm, the transaction would be recorded on the U.S. balance of payments as a:
a. Capital account debit
b. Capital account credit
c. Current account debit
d. Current account credit

14. If the United States government sells military hardware to Saudi Arabia, the transaction would be recorded on the U.S. balance of payments as a:
a. Current account debit
b. Current account credit
c. Capital account debit
d. Capital account credit

15. The U.S. balance of trade is determined by:
a. Exchange rates
b. Growth of economies overseas
c. Relative prices in world markets
d. All of the above

17. If the U.S. faces a balance-of-payments deficit on the current account, it must run a surplus on:
a. The official settlements account
b. The capital account
c. Either the official settlements account or the capital account
d. Both the official settlements account and the capital account

18. The current account of the U.S. balance of payments does not include:
a. Investment income
b. Merchandise exports and imports
c. The sale of securities to foreigners
d. Unilateral transfers

20. The value to American residents of income earned from overseas investments shows up in which account in the U.S. balance of payments?
a. Current account
b. Trade account
c. Unilateral transfers account
d. Capital account

Table 10.2. International Investment Position of the United States

U.S. assets abroad
U.S. government assets $800 billion
U.S. private assets $200 billion

21. Consider Table 10.2. The U.S. balance of international indebtedness suggests that the United States is a net:
a. Debtor
b. Creditor
c. Spender
d. Exporter

22. For the first time since World War I, in 1985 the United States became a net international:
a. Exporter
b. Importer
c. Debtor
d. Creditor

23. A country that is a net international debtor initially experiences:
a. An augmented savings pool available to finance domestic spending
b. A higher interest rate, which leads to lower domestic investment
c. A loss of funds to trading partners overseas
d. A decrease in its services exports to other countries

27. In the balance of payments, the statistical discrepancy is used to:
a. Ensure that the sum of all debits matches the sum of all credits
b. Ensure that trade imports equal the value of trade exports
c. Obtain an accurate account of a balance-of-payments deficit
d. Obtain an accurate account of a balance-of-payments surplus

28. All of the following are credit items in the balance of payments, except:
a. Investment inflows
b. Merchandise exports
c. Payments for American services to foreigners
d. Private gifts to foreign residents

29. All of the following are debit items in the balance of payments, except:
a. Capital outflows
b. Merchandise exports
c. Private gifts to foreigners
d. Foreign aid granted to other nations

30. The role of ____ is to direct one nation’s savings into another nation’s investments:
a. Merchandise trade flows
b. Services flows
c. Current account flows
d. Capital flows

31. When a country realizes a deficit on its current account:
a. Its net foreign investment position becomes positive
b. It becomes a net demander of funds from other countries
c. It realizes an excess of imports over exports on goods and services
d. It becomes a net supplier of funds to other countries

35. Concerning a country’s business cycle, rapid growth of production and employment is commonly associated with:
a. Large or growing trade deficits and current account deficits
b. Large or growing trade deficits and current account surpluses
c. Small or shrinking trade deficits and current account deficits
d. Small or shrinking trade deficits and current account surpluses

36. The burden of a current account deficit would be the least if a nation uses what it borrows to finance:
a. Unemployment compensation benefits
b. Social Security benefits
c. Expenditures on food and recreation
d. Investment on plant and equipment

37. Concerning a country’s business cycle, ____ is commonly associated with large or growing current account deficits:
a. Rapid growth rates of production and employment
b. Slow growth rates of production and employment
c. Falling interest rates on government securities
d. Falling interest rates on corporate securities

38. According to researchers at the Federal Reserve, the loss of jobs associated with a deficit in the current account tends to be:
a. Offset by the increase of jobs associated with a surplus in the capital account
b. Reinforced by the decrease of jobs associated with a surplus in the capital account
c. A threat to the level of employment for the economy as a whole
d. Of no long-run economic consequence for workers who lose their jobs

TRUE/FALSE

Table 10.3 shows hypothetical transactions, in billions of U.S. dollars, that took place during a year.

7. Refer to Table 10.3. The payments data suggest that the United States was a “net demander” of $30 billion from the rest of the world.

8. The balance of payments refers to the stock of trade and investment transactions that exists at a particular point in time.

9. Referring to the balance-of-payments statement, an international transaction refers to the exchange of goods, services, and assets between residents of one country and those abroad.

10. The balance of payments includes international transactions of households and businesses, but not government.

11. Because the balance of payments utilizes double-entry accounting, merchandise exports will always be in balance with merchandise imports.

12. On the U.S. balance-of-payments statement, the following transactions are credits, leading to the receipt of dollars from foreigners: merchandise exports, transportation receipts, income received from investments abroad, and investments in the United States by foreign residents.

13. On the U.S. balance of payments, the following transactions are debits, leading to payments to foreigners: merchandise imports, travel expenditures, gifts to foreign residents, and overseas investments by U.S. residents.

14. The “goods and services” account of the balance of payments shows the monetary value of international flows associated with transactions in goods, services, and unilateral transfers.

15. An increase in import restrictions by the U.S. government tends to promote a merchandise-trade surplus.

16. Services transactions on Canada’s balance-of-payments statement would include Canadian ships transporting lumber to Japan, foreign tourists spending money in Canada, and Canadian engineers designing bridges in China.

17. On the balance-of-payments statement, dividend and interest income are classified as capital-account transactions.

18. A surplus on Germany’s goods-and-services balance indicates that Germany has sold more goods and services to foreigners than it has bought from them over a one-year period.

19. The merchandise-trade account on the balance-of-payments statement is defined the same way as “net exports” which constitutes part of the nation’s gross domestic product.

20. A positive balance on the goods-and-services account of the balance of payments indicates an excess of exports over imports which must be added to the nation’s gross domestic product.

21. For the United States, merchandise trade has generally constituted the largest portion of its goods-and-services account.

22. Unilateral transfers refer to two-sided transactions, reflecting the movement of goods and services in one direction with corresponding payments in the other direction.

23. Unilateral transfers consist of private-sector transfers, such as church contributions to alleviate starvation in Africa, as well as governmental transfers, such as foreign aid.

25. On the U.S. balance-of-payments statement, a capital inflow would occur if a Swiss resident purchases the securities of the U.S. government.

26. If Toyota Inc. of Japan builds an automobile assembly plant in the United States, the Japanese capital account would register an outflow.

27. If Bank of America receives repayment for a loan it made to a Mexican firm, the U.S. capital account would register an inflow.

28. On the balance-of-payments statement, a capital inflow can be likened to the import of goods and services.

29. The capital account of the balance of payments includes private-sector transactions as well as official-settlements transactions of the home country’s central bank.

30. If the current account of the balance of payments registers a deficit, the capital account registers a surplus, and vice versa.

31. Concerning the balance of payments, a current-account surplus means an excess of exports over imports of goods, services, investment income, and unilateral transfers.

32. If a country realizes a current-account deficit in its balance of payments, it becomes a net supplier of funds to the rest of the world.

33. Concerning the balance of payments, a current-account deficit results in a worsening of a country’s net foreign investment position.

34. In the balance-of-payments statement, statistical discrepancy is treated as part of the merchandise trade account because merchandise transactions are generally the most frequent source of error.

35. Because a large number of international transactions fail to get recorded, statisticians insert a residual, known as statistical discrepancy, to ensure that total debits equal total credits.

36. Concerning the balance of payments, the goods-and-services balance is commonly referred to as the “trade balance” by the news media.

37. Since the 1970s, the merchandise trade account of the U.S. balance of payments has registered deficit.

38. Although the United States has realized merchandise trade deficits since the early 1970s, its goods-and-services balance has always registered surplus.

39. In the past two decades, the U.S. services balance has generally registered surplus.

40. The U.S. unilateral-transfers balance has consistently registered surplus in the past two decades.

41. Because the balance of payments is a record of the economic transactions of a country over a period of time, it is a “flow” concept.

42. The United States would be a “net creditor” if the value of U.S. assets abroad exceeded the value of foreign assets in the United States.

43. If a country consistently realizes a current-account surplus in its balance of payments, it likely will become a “net debtor” in its balance of international indebtedness.

44. By the mid-1980s, the United States had evolved from the status of a net-creditor nation to a net-debtor nation in its balance of international indebtedness.

45. The net-debtor status, that the United States achieved in its balance of international indebtedness by the mid-1980s, reflected the continuous current-account surplus that the United States attained in its balance of payments during the 1970s.

46. Although a net-debtor country may initially benefit from an inflow of savings from abroad, over the long run continued borrowing results in growing dividend payments to foreigners and a drain on the debtor-country’s economic resources.

47. The official reserve assets of the United States consist of holdings of gold and foreign corporate securities.

48. That U.S. importers purchase bananas from Brazil constitutes a debit transaction on the U.S. balance of payments.

49. That German investors collect interest income on their holdings of U.S. Treasury bills constitutes a credit transaction on the U.S. balance of payments.

50. That U.S. charities donate funds to combat starvation in Africa constitutes a debit transaction on the U.S. balance of payments.

51. To reduce a current account deficit, a country should either decrease the budget deficit of its government or reduce investment spending relative to saving.

52. Most economists belief that in the 1980s, a massive outflow of capital caused a current account deficit for the United States.

53. A current account deficit for the United States necessarily reduces the standard of living for American households.

54. Rapid growth of production and employment is commonly associated with large or growing trade surpluses and current account surpluses.

56. For the United States, a consequence of its current account deficit is a growing foreign ownership of the capital stock of the United States and a rising fraction of U.S. income that must be diverted abroad in the form of interest and dividends to foreigners.

57. Most economists contend that any reduction in the current account deficit is better achieved through increased national saving than through reduced domestic investment.

SHORT ANSWER

1. What are the components of the current account of the balance of payments?

2. Concerning the balance of international indebtedness, when is a country a net creditor or a net debtor?

ESSAY

1. How do we measure the international investment position of the United States at any point in time? How did the U.S. become a net debtor nation so rapidly?

2. What does a current account deficit mean?

CHAPTER 11—FOREIGN EXCHANGE

MULTIPLE CHOICE

1. Assume you are an American exporter and expect to receive 50 pounds sterling at the end of 60 days. You can remove the risk of loss due to a devaluation of the pound sterling by:
a. Selling sterling in the forward market for 60-day delivery
b. Buying sterling now and selling it at the end of 60 days
c. Selling the dollar equivalent in the forward market for 60-day delivery
d. Keeping the sterling in Britain after it is delivered to you

2. Which of the following tends to cause the U.S. dollar to appreciate in value?
a. An increase in U.S. prices above foreign prices
b. Rapid economic growth in foreign countries
c. A fall in U.S. interest rates below foreign levels
d. An increase in the level of U.S. income

3. Concerning the covering of exchange market risks–assuming that a depreciation of the domestic currency is anticipated, one can say that there is an incentive for:
a. Exporters to rush to cover their future needs
b. Importers to rush to cover their future needs
c. Both exporters and importers to rush to cover their future needs
d. Neither exporters nor importers to rush to cover their future needs

4. When short-term interest rates become lower in Tokyo than in New York, interest arbitrage operations will most likely result in a:
a. Increase in the spot price of the yen
b. Increase in the forward price of the dollar
c. Sale of dollars in the forward market
d. Purchase of yen in the spot market

5. An appreciation in the value of the U.S. dollar against the British pound would tend to:
a. Discourage the British from buying American goods
b. Discourage Americans from buying British goods
c. Increase the number of dollars that could be bought with a pound
d. Discourage U.S. tourists from traveling to Britain

6. Concerning the foreign exchange market, one can best say that:
a. There is a spot market for virtually every currency in the world
b. The market is highly centralized like the stock exchange
c. Most foreign exchange payments are made with bank notes
d. The values of the forward and spot rates are always in agreement

7. Suppose researchers discover that Swiss beer causes cancer when given in large amounts to British mice. This finding would likely result in a (an):
a. Increase in the demand for Swiss francs
b. Decrease in the demand for Swiss francs
c. Increase in the supply of Swiss francs
d. Decrease in the supply of Swiss francs

8. Suppose that real incomes increase more rapidly in the United States than in Mexico. In the United States, this situation would likely result in a (an):
a. Increase in the demand for pesos
b. Decrease in the demand for pesos
c. Increase in the supply of pesos
d. Decrease in the supply of pesos

9. A depreciation of the dollar refers to:
a. A fall in the dollar price of foreign currency
b. An increase in the dollar price of foreign currency
c. A loss of foreign-exchange reserves for the U.S.
d. An intervention in the international money market

10. If Canadian speculators believed the Swiss franc was going to appreciate against the U.S. dollar, they would:
a. Purchase Canadian dollars
b. Purchase U.S. dollars
c. Purchase Swiss francs
d. Sell Swiss francs

11. A major difference between the spot market and the forward market is that the spot market deals with:
a. The immediate delivery of currencies
b. The merchandise trade account
c. Currencies traded for future delivery
d. Hedging of international currency risks

12. The exchange rate is kept the same in all parts of the market by:
a. Forward cover
b. Hedging
c. Exchange speculation
d. Exchange arbitrage

13. If you have a commitment to pay a friend in Britain 1,000 pounds in 30 days, you could remove the risk of loss due to the appreciation of the pound by:
a. Buying dollars in the forward market for delivery in 30 days
b. Selling dollars in the forward market for delivery in 30 days
c. Buying the pounds in the forward market for delivery in 30 days
d. Selling the pounds in the forward market for delivery in 30 days

14. An increase in the dollar price of other currencies tends to cause:
a. U.S. goods to be cheaper than foreign goods
b. U.S. goods to be more expensive than foreign goods
c. Foreign goods to be more expensive to residents of foreign nations
d. Foreign goods to be cheaper to residents of the United States

15. The balance on merchandise trade:
a. Must be negative
b. Must be positive
c. Must be zero
d. May be negative, positive, or zero

16. Which of the following would not induce the U.S. demand curve for foreign exchange to shift backward to the left?
a. Worsening American tastes for goods produced overseas
b. Increasing interest rates in the U.S. compared to those overseas
c. A fall in the level of U.S. income
d. A depreciation in the U.S. dollar against foreign currencies

17. A U.S. export company scheduled to receive 1 million pounds six months from today can hedge its foreign exchange risk by:
a. Buying today 1 million pounds in the forward market for delivery in six months
b. Buying 1 million pounds in the spot market for delivery in six months
c. Selling 1 million pounds in the spot market for delivery in six months
d. Selling today 1 million pounds in the forward market for delivery in six months

18. Over time, a depreciation in the value of a nation’s currency in the foreign exchange market will result in:
a. Exports rising and imports falling
b. Imports rising and exports falling
c. Both imports and exports rising
d. Both imports and exports falling

19. Grain shortages in countries that buy large amounts of grain from the United States would increase the demand for American grain and:
a. Reduce the demand for dollars
b. Increase the demand for dollars
c. Reduce the supply of dollars
d. Increase the supply of dollars

20. Suppose the exchange rate between the Japanese yen and the U.S. dollar is 100 yen per dollar. A Japanese stereo with a price of 60,000 yen will cost:
a. $60
b. $600
c. $6000
d. None of the above

22. Suppose that a Swiss watch that costs 400 francs in Switzerland costs $200 in the United States. The exchange rate between the franc and the dollar is:
a. 2 francs per dollar
b. 1 franc per dollar
c. $2 per franc
d. $3 per franc

23. In the early 1980s, the Federal Reserve pursued a tight monetary policy. All else being equal, the impact of that policy was to ____ interest rates in the United States relative to those in Europe and cause the dollar to ____ against European currencies.
a. Decrease, depreciate
b. Decrease, appreciate
c. Increase, depreciate
d. Increase, appreciate

24. Under a system of floating exchange rates, the Swiss franc would depreciate in value if which of the following occurs?
a. Price inflation in France
b. An increase in U.S. real income
c. A decrease in the Swiss money supply
d. Falling interest rates in Switzerland

25. A depreciation of the dollar will have its most pronounced impact on imports if the demand for imports is:
a. Constant
b. Inelastic
c. Elastic
d. Unitary elastic

26. During the era of dollar appreciation, from 1981 to 1985, a main reason why the dollar did not fall in value was:
a. Flows of foreign investment into the United States
b. Rising price inflation in the United States
c. A substantial decrease in U.S. imports
d. A substantial increase in U.S. exports

27. Which financial instrument provides a buyer the right to purchase or sell a fixed amount of currency at a prearranged price, within a few days to a couple of years?
a. Letter of credit
b. Foreign currency option
c. Cable transfer
d. Bill of exchange

28. Given the foreign currency market for the Swiss franc, the supply of francs slopes upward, because as the dollar price of the franc rises:
a. America’s demand for Swiss merchandise rises
b. America’s demand for Swiss merchandise falls
c. Switzerland’s demand for American merchandise rises
d. Switzerland’s demand for American merchandise falls

29. In a supply-and-demand diagram for Japanese yen, with the exchange rate in dollars per yen on the vertical axis, the demand schedule for yen is drawn sloping:
a. Upward
b. Vertical
c. Downward
d. Horizontal

30. Suppose there occurs an increase in the Canadian demand for Japanese computers. This results in:
a. An increase in the demand for yen
b. A decrease in the demand for yen
c. An increase in the supply of yen to Canada
d. A decrease in the supply of yen to Canada

Table 11.1 gives the exchange rate quotations for the U.S. dollar and the British pound.

31. Consider Table 11.1. If one were to buy pounds for immediate delivery, on Tuesday the dollar cost of each pound would be:
a. $0.7008
b. $0.7037
c. $1.4211
d. $1.4270

32. Consider Table 11.1. If one were to sell dollars for immediate delivery, on Tuesday the pound cost of each dollar would be:
a. .7008 pounds per dollar
b. .7037 pounds per dollar
c. 1.4270 pounds per dollar
d. 1.4211 pounds per dollar

33. Consider Table 11.1. Comparing Tuesday to the previous Monday, by Tuesday the dollar had:
a. Depreciated against the pound
b. Appreciated against the pound
c. Not changed against the pound
d. None of the above

35. Which method of trading currencies involves the conversion of one currency into another at one point in time with an agreement to reconvert it back to the original currency at some point in the future?
a. Forward transaction
b. Futures transaction
c. Spot transaction
d. Swap transaction

38. In the interbank market for foreign exchange, the ____ refers to the price that a bank is willing to pay for a unit of foreign currency.
a. Offer rate
b. Bid rate
c. Spread rate
d. Transaction rate

39. In the interbank market for foreign exchange, the ____ refers to the price for which a bank is willing to sell a unit of foreign currency.
a. Offer rate
b. Option rate
c. Futures rate
d. Bid rate

40. In the interbank market for foreign exchange, the ____ refers to the difference between the offer rate and the bid rate.
a. Cross rate
b. Option
c. Arbitrage
d. Spread

41. A corporation dealing in foreign exchange may desire to obtain an exchange quote between the pound and franc, whose values are both expressed relative to the dollar. ____ are used to determine such a relationship.
a. Spot exchange rates
b. Forward exchange rates
c. Cross exchange rates
d. Option exchange rates

42. Suppose the exchange value of the British pound is $2 per pound while the exchange value of the Swiss franc is 50 cents per pound. The cross exchange rate between the pound and the franc is:
a. 1 franc per pound
b. 2 francs per pound
c. 3 francs per pound
d. 4 francs per pound

Exhibit 11.1

Assume the following: (1) the interest rate on 6-month treasury bills is 8 percent per annum in the United Kingdom and 4 percent per annum in the United States; (2) today’s spot price of the pound is $1.50 while the 6-month forward price of the pound is $1.485.

43. Refer to Exhibit 11.1. By investing in U.K. treasury bills rather than U.S. treasury bills, and not covering exchange rate risk, U.S. investors earn an extra return of:
a. 4 percent per year, 1 percent for the 6 months
b. 4 percent per year, 2 percent for the 6 months
c. 2 percent per year, 0.5 percent for the 6 months
d. 2 percent per year, 1 percent for the 6 months

45. Refer to Exhibit 11.1. If the price of the 6-month forward pound were to ____, U.S. investors would no longer earn an extra return by shifting funds to the United Kingdom.
a. Rise to $1.52
b. Rise to $1.53
c. Fall to $1.48
d. Fall to $1.47

46. Assume that you are the Chase Manhattan Bank of the United States, and you have 1 million Swiss francs in your vault that you will need to use in 30 days. Moreover, you need 500,000 British pounds for the next 30 days. You arrange to loan your francs to Barclays Bank of London for 30 days in exchange for 500,000 pounds today, and reverse the transaction at the end of 30 days. You have just arranged a:
a. Forward contract
b. Futures contract
c. Spot contract
d. Currency swap

Figure 11.1 illustrates the supply and demand schedules for the Swiss franc. Assume that exchange rates are flexible.

Figure 11.1. Supply and Demand Schedules of Francs

47. Refer to Figure 11.1. At the equilibrium exchange rate of ____ per franc, ____ francs will be purchased at a total dollar cost of ____.
a. $.50, 5 million, $2.5 million
b. $.50, 5 million, $1.5 million
c. $.70, 3 million, $2.1 million
d. $.70, 7 million, $4.9 million

48. Refer to Figure 11.1. Suppose the exchange rate is $.70 per franc. At this exchange rate there is an ____ of francs which leads to a ____ in the dollar price of the franc, a (an) ____ in the quantity of francs supplied, and a (an) ____ in the quantity of francs demanded.
a. Excess demand, rise, increase, decrease
b. Excess demand, rise, decrease, increase
c. Excess supply, fall, decrease, increase
d. Excess supply, fall, increase, decrease

49. Refer to Figure 11.1. Suppose the exchange rate is $.30 per franc. At this exchange rate there is an ____ of francs which leads to a ____ in the dollar price of the franc, a (an) ____ in the quantity of francs supplied, and a (an) ____ in the quantity of francs demanded.
a. Excess demand, rise, increase, decrease
b. Excess demand, rise, decrease, increase
c. Excess supply, fall, decrease, increase
d. Excess supply, fall, increase, decrease

50. Refer to Figure 11.1. Suppose the exchange rate is $.70 per franc. Free-market forces would lead to a (an) ____ of the dollar against the franc and a (an) ____ in U.S. international competitiveness.
a. Depreciation, improvement
b. Depreciation, worsening
c. Appreciation, improvement
d. Appreciation, worsening

51. Refer to Figure 11.1. Suppose the exchange rate is $.30 per franc. Free-market forces would lead to a (an) ____ of the dollar against the franc and a (an) ____ in U.S. international competitiveness:
a. Depreciation, improvement
b. Depreciation, worsening
c. Appreciation, improvement
d. Appreciation, worsening

The figure below illustrates the market for Swiss francs in a world of market-determined exchange rates. Assume the equilibrium exchange rate is $0.5 per franc, given by the intersection of schedules S0 and D0.

Figure 11.2. Market for Francs

52. Refer to Figure 11.2. A shift in the demand for francs from D0 to D1 or a shift in the supply of francs from S0 to S2, would result in a (an):
a. Depreciation in the dollar against the franc
b. Appreciation in the dollar against the franc
c. Unchanged dollar/franc exchange rate
d. None of the above

53. Refer to Figure 11.2. A shift in the demand for francs from D0 to D2, or a shift in the supply of francs from S0 to S1, would result in a (an):
a. Depreciation in the dollar against the franc
b. Appreciation in the dollar against the franc
c. No change in the dollar/franc exchange rate
d. None of the above

54. A (An) ____ is an arrangement by which two parties exchange one currency for another and agree that the exchange will be reversed at a stipulated date in the future:
a. Arbitrage
b. Swap
c. Option
d. Hedge

56. Refer to Table 11.2. At the exchange rate of $1.40 per pound, there is an ____ for pounds. This imbalance causes ____ in the price of the pound, which leads to ____ in the quantity of pounds supplied and ____ in the quantity of pounds demanded.
a. Excess supply, a decrease, an increase, a decrease
b. Excess supply, an increase, a decrease, an increase
c. Excess demand, an increase, an increase, a decrease
d. Excess demand, an increase, a decrease, an increase

57. Refer to Table 11.2. At the exchange rate of $1.80 per pound, there is an ____ for pounds. This imbalance causes ____ in the price of the pound, which leads to ____ in the quantity of pounds supplied and ____ in the quantity of pounds demanded.
a. Excess supply, a decrease, a decrease, an increase
b. Excess supply, an increase, a decrease, an increase
c. Excess demand, an increase, an increase, a decrease
d. Excess demand, an increase, a decrease, an increase

60. Refer to Table 11.4. On Wednesday, the 30-day forward franc was selling at a:
a. 1 percent premium per annum against the dollar
b. 2 percent premium per annum against the dollar
c. 1 percent discount per annum against the dollar
d. 2 percent discount per annum against the dollar

61. Refer to Table 11.4. On Wednesday, the 90-day forward franc was selling at a:
a. 0.8 percent premium per annum against the dollar
b. 1.6 percent premium per annum against the dollar
c. 0.8 percent discount per annum against the dollar
d. 1.6 percent discount per annum against the dollar

62. Refer to Table 11.4. On Wednesday, the 180-day forward franc was selling at a:
a. 0.6 percent premium per annum against the dollar
b. 1.6 percent premium per annum against the dollar
c. 0.6 percent discount per annum against the dollar
d. 1.6 percent discount per annum against the dollar

63. Refer to Table 11.4. Comparing the franc’s forward rates against the franc’s spot rate, the exchange market’s consensus is that over the period of a forward contract, the franc’s spot rate will:
a. Depreciate against the dollar
b. Appreciate against the dollar
c. Remain constant against the dollar
d. None of the above

64. The offer rate
a. Is the price at which the bank is willing to sell a unit of foreign currency
b. Is the price that the bank is willing to pay for a unit of foreign currency
c. Is synonymous with the spread rate
d. None of the above

65. When the dollar depreciates
a. U.S. exporters tend to sell more goods in foreign markets
b. U.S. consumers travel abroad more cheaply
c. More foreign tourists can afford to visit the United States
d. both a and c

66. When the dollar gets stronger
a. U.S. firms become more competitive in international market
b. Foreign tourists travel in the U.S. at a higher cost
c. U.S. inflation increases
d. U.S. consumers face higher prices on foreign goods

TRUE/FALSE

1. Similar to stock and commodity exchanges, the foreign exchange market is an organized structure with a central meeting place and formal licensing requirements.

2. Most foreign exchange transactions are conducted between commercial banks and household customers.

4. A person needing foreign exchange immediately would purchase it on the spot market.

5. Most foreign exchange trading is carried out in the forward market.

6. Swap transactions among commercial banks involve the conversion of one currency to another at one point with an agreement to reconvert it back into the original currency at some point in the future.

7. The bid rate refers to the price at which a bank is willing to sell a unit of foreign currency; the offer rate is the price at which a bank is willing to buy a unit of foreign currency.

8. A commercial bank profits from foreign-exchange trading when its bid rate exceeds its offer rate.

9. The “spread” is a bank’s profit margin on foreign exchange trading and equals the difference between the bid rate and the offer rate.

10. If Citibank quoted bid and offer rates for the Swiss franc at $.4850/$.4854, the bank would be prepared to buy, say, 1 million francs for $485,000 and sell them for $485,400.

11. If Chase Manhattan Bank quotes bid and offer rates for the Swiss franc at $.5250/$.5260, the bank would realize profits of $1,000 on the purchase and sale of 1 million francs.

12. If a Citibank dealer expects the Swiss franc to appreciate against the U.S. dollar, she will attempt to lower both bid and offer rates for the franc, attempting to persuade other dealers to buy francs from Citibank and dissuade other dealers from selling francs to Citibank.

13. If a Citibank dealer expects the Swiss franc to depreciate in the future, he will lower bid and offer rates for the franc in order to discourage other dealers from selling francs to Citibank and persuade other dealers to buy francs from Citibank.

14. If it takes $0.18544 to purchase 1 French franc, it takes 5.3926 francs to purchase $1.

15. If it takes 113.28 yen to buy $1, it takes $.009624 to buy 1 yen.

16. If it takes $1.5515 to buy 1 pound and $0.6845 to buy 1 franc, it takes 2.27 francs to buy 1 pound.

17. “Futures” currency contracts are issued by commercial banks and are tailored in size to the needs of the exporter or importer, while “forward” currency contracts are issued by the International Monetary Market in standardized round lots.

18. A foreign currency option is an agreement between a holder (corporation) and a writer (commercial bank) giving the holder the right to buy or sell a certain amount of foreign currency at any time through some specified date.

19. A “call” option gives General Motors the right to sell pounds at a specified price, while a put option gives General Motors the right to buy pounds at a specified price.

20. The demand for foreign exchange is derived from credit transactions on the balance of payments.

21. The U.S. demand for pounds is derived from U.S. exports to the United Kingdom, U.K. investments in the United States, and U.K. tourist expenditures in the United States.

22. As the dollar’s exchange value appreciates against the pound, U.S. residents tend to import more British goods and thus demand more pounds.

23. As the dollar depreciates against the peso, U.S. residents tend to import more Mexican goods and thus demand more pesos.

24. The supply of francs is derived from the desire of the Swiss to purchase German goods, make investments in Germany, repay debts to German lenders, and extend transfer payments to German residents.

25. The demand schedule for Swiss francs is always downsloping while the supply schedule of francs is always upsloping.

26. The supply schedule of yen has a positive-sloping region which corresponds to the inelastic region on the Japanese demand schedule for foreign currency.

27. The supply schedule of pesos has a negative-sloping region corresponding to the inelastic region on the Mexican demand schedule for foreign currency.

28. If the Swiss demand for dollars is elastic, a depreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

29. If the Swiss demand for dollars is inelastic, an appreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

30. If the Swiss demand for dollars is elastic, an appreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

31. If the Swiss demand for dollars is inelastic, a depreciation of the dollar against the franc will lead to a greater quantity of francs being supplied to the foreign exchange market to obtain dollars.

32. Movements along the demand schedule for pounds are caused by changes in the pound’s exchange rate.

33. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, an increase in the demand schedule causes an appreciation of the dollar against the pound.

34. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, a decrease in the demand schedule causes an appreciation of the dollar against the pound.

35. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, an increase in the supply schedule causes an appreciation of the dollar against the pound.

36. Given an upward-sloping supply schedule of pounds and a downward-sloping demand schedule for pounds, a decrease in the supply schedule causes an appreciation of the dollar against the pound.

37. The trade-weighted dollar is the weighted average of the exchange rates between the dollar and the most important industrial-country trading partners of the United States.

38. If the trade-weighted dollar moves from an index value to 100 to 110, the dollar depreciates by 10 percent against the trade-weighted averages of the exchange rates of the major trading partners of the United States.

39. An increase in the trade-weighted value of the dollar indicates a dollar appreciation relative to the currencies of its major trading partners and a worsening of U.S. international competitiveness.

40. With arbitrage, a trader attempts to purchase a foreign currency at a low price and, at a later date, resell the currency at a higher price in order to make a profit.

41. Arbitrage results in a riskless profit since a trader purchases a currency at a low price and simultaneously resells it at a higher price.

42. If the exchange rate is $0.01 per yen in New York and $0.015 per yen in Tokyo, an arbitrager could profit by buying yen in Tokyo and simultaneously sell them in New York.

43. Currency arbitrage tends to result in identical yen/dollar exchange rates in New York and in Tokyo.

44. In the forward market, the exchange rate is agreed on at the time of the currency contract, but payment is not made until the future delivery of the currency actually takes place.

45. If the spot price of the Swiss franc is $0.4020 and the 90-day forward franc sells for $0.4026, the franc is at a 90-day forward discount of $0.0006, or at a 0.2 percent forward discount per annum against the dollar.

46. Suppose that Sears owes 1 million yen to a Japanese electronics manufacturer in 3 months. It could hedge against the risk of a depreciation of the dollar against the yen by contracting to purchase 1 million yen in the forward market, at today’s forward rate, for delivery in 3 months.

47. Assume that Boeing anticipates receiving 20 million yen in 3 months from exports of jumbo jets to a Japanese airline. The firm could hedge against the risk of a depreciation of the dollar against the yen by contracting to sell its expected yen proceeds for dollars in the forward market at today’s forward rate.

48. A U.S. investor’s extra rate of return on an investment in France, as compared to the United States, equals the interest-rate differential adjusted for any change in the dollar/franc exchange rate.

49. A currency speculator’s goal is to buy a currency at a low price and immediately resell it at a higher price, thus realizing a riskless profit.

50. Stabilizing speculation reinforces market forces by intensifying an appreciation or a depreciation in a currency’s exchange value.

SHORT ANSWER

1. What foreign exchange transactions do banks typically engage in?

2. How is the equilibrium rate of exchange determined?

ESSAY

1. Is it possible to trade foreign exchange in the futures market? How does such trading differ from the forward market?